Transcription
All right, hello everyone!
Okay, so here we go. In light of recent California wildfire events and actions happening in the state of California with the LA wildfires, I just wanted to pop in and give some information on my background and what I'm seeing in the market.
I wanted to provide a little bit of history on California wildfires and California insurance and reinsurance. I think it's important for people to understand how absolutely insane this market has been for the last decade.
So, I guess we'll jump right into it. I've got a little bit of an agenda. Let's throw the agenda up.
Oh hey, look, some people are here! 255 people coming to listen about California wildfire insurance and reinsurance.
Okay, so this market is totally crazy, and I wanted to give some people some perspective so they can have an understanding of what's going on with the insurance market and the reinsurance market and why things are so crazy.
I think there's been a lot of insanity with people talking about the insurance market and how crazy it is, and I just want to show people exactly what's going on behind the scenes and how nuts it's been for the last decade.
Again, a little bit about me: my background is in business and economics. I got a job in reinsurance; I'm a reinsurance broker. I sell and structure tranches of risk from insurance companies externally to reinsurance entities. The entire goal is to offset volatility on an insurance company's balance sheet.
So, I joined a reinsurance brokerage firm right out of college, and I've been working in reinsurance broking ever since—it's been about 11 years. The business that I've focused on has been primarily property and casualty West Coast business. I've worked on some nationwide things and some regional things, but primarily West Coast property and casualty business.
So really, I've worked on wildfire my entire career, and I've been able to see what's happened in this marketplace for the last decade, which is just totally crazy. People need to hear about this stuff because it's just totally nuts.
So here's the agenda for today: we're going to go over the California wildfire insurance and reinsurance market. We'll talk a little bit about the current status—obviously, there's a huge wildfire in LA—insurance and reinsurance market history in California, the dynamics of the marketplace, and what's going on here.
This thing is totally weird. Then we'll talk about wildfire loss occurrence definitions, which gets crazy. We'll compare that to hurricanes and then talk about the California wildfire fund and utility company involvement.
So let's just jump right into it. I guess we might as well check the chat—some people hanging out. Cool!
All right, was the LA fire of this scale on your radar? Absolutely, this is absolutely on my radar. Any other questions real quick before we jump in here?
All right, cool! Got no whiskey today, just tea. Thanks for joining.
Okay, so I wanted to get into some statistics. You guys got to know about this marketplace because this market is pretty nuts.
What I have on the screen—maybe I'll make it a little bit bigger so you can see this—there are so many things, but I'll go from left to right.
What I wanted to show here is that the state of California insurance market was the most profitable market in the entire United States prior to the year 2017.
These red squares here on the left-hand side show 2017 and 2018. There was a significant kind of gold rush to the California insurance market. This economy is just exploding. You've got Silicon Valley booming, people moving to California left and right, and the population is expanding super rapidly.
Largely, there were no big catastrophes. There was a big earthquake in 1989 and the 1994 Northridge earthquake as well, but after that, there really weren't very many large catastrophes in the state of California.
So that led to a really big string of profitability. What you're looking at on the screen here is the homeowner line of business loss ratio over time.
You can see in 2004, the loss ratio was 31%. In 2007-2008, there were some medium-sized wildfires that happened—there was one called the Witch Fire in that year. It led to some losses, but then in 2009, we went back to a 36% loss ratio.
Then there was a string of just four or five years in a row of incredibly profitable California business. Insurance companies were running really profitably, with loss ratios of 43%, 42%, 45%, and 47%.
For those that are unaware, the loss ratio means you take all of your premium income—you get premium in the door—and you have to pay losses out. So it's the proportion of loss relative to the premium that you bring in the door.
That gives you that loss ratio figure. Loss ratio figures are a good metric for how insurance companies are managing their portfolio or their balance sheet.
On top of the loss ratio, insurance companies also have to pay expenses. This isn't like, you know, one minus this figure isn't profit. You also have to factor in expenses. Most expense ratios on average are around 30%.
Getting back into the meat and potatoes here: in came 2015. There was the Valley Fire that happened, which led to some losses in the market. It wasn't a very big event; everybody just kind of brushed it off as a 2008-sized event.
Then 2016 happened, and I think there were a couple of small wildfires again—not that big of a deal. Then 2017 rolls around.
2017 was totally nuts. Somebody asked this question: 100% would be a total loss of profit. Absolutely!
So in 2017, the loss ratio was 111%. The California industry for homeowners brought in $7.6 billion of premium and paid out $15.3 billion of loss.
So the entire industry in California lost just on the homeowners line—lost $7.7 billion in 2017 alone just from loss. Then you have to factor in the expense ratio.
So you've got an expense ratio on top of that. The profit margin that the insurance market was operating in 2017 was a negative 131% profit margin.
The industry effectively lost $10 billion on the homeowners line alone in 2017. If you look at this column here, I've created a column called net profit.
What this column of net profit does is it takes the loss ratio plus the average expense ratio of 30% and gets you to a profit margin percentage for that individual year. Then I backed into a net profit dollar figure relative to the earned premium.
As you can see in this cell here for 2017, the year 2017 effectively erased the prior nine years of profit. That was an incredible string of profitability.
Everything was good; everybody was making money. California was great. These insurance companies were just like, "Hell yeah, hell yeah, hell yeah!"
Then boom! 2017 rolls around, and you get absolutely obliterated. It's not even close. You just get absolutely obliterated by these huge wildfires.
Then 2018 rolls around, and everybody's like, "Oh my God, 2017 was so horrible! Jesus Christ, maybe we'll get a nice good year; it won't be that bad."
In 2018, we had the Paradise Wildfire. This is where the entire town of Paradise was wiped out. Just two back-to-back years of absolutely getting smacked in the face.
In 2018, you had $7.9 billion of effectively net loss just on the homeowners line of business.
So, you know, everybody thinks these insurance companies are just incredibly profitable enterprises and they're just stealing all this money from all these people, but really, the math here isn't good.
This is not a sexy business model. If you look at the total weighted net profit margin from 2023 back to 2004, it's 9.1%. If you take the pure average, it's 10%.
If you take the standard deviation on that number, your standard deviation is 44.6%. That means that while on average you get a 9% return or 10% return, you can have a 100% loss year or a 130% loss year.
That's a horrible proposition. That's so much volatility just to get a 9% return on this line of business. That's just an incredible amount of volatility that is really difficult to manage.
I'll explain why it's difficult to manage; it kind of comes into this reinsurance perspective.
Prior to 2017, let's go back to our agenda here.
Okay, so that's market history. Just thinking about statistics, let's talk about wildfire loss occurrence definitions, and then we'll get back into this.
So, wildfire loss occurrence definitions. Let's bring up our Google Earth.
This is a pretty crazy scenario here, right? One of the biggest challenges in the reinsurance market and managing the volatility of an insurance company's balance sheet is how on Earth, as a reinsurer, do you define a wildfire event?
How do you do it? This is far more complicated than many people probably even care about or even understand.
For example, in 2017, some of the wildfires that happened—I believe that was the year with the Woy and the Santa Rosa fires at the same time.
You had Malibu and Santa Rosa burning at the exact same time. So, Santa Rosa is up here north of San Francisco, and then Malibu is down here in LA County.
You have these events occurring in the same time period. All of these Santa Ana winds and Diablo winds blew at the exact same time, and you had these exact same wind conditions, and then these fires just exploded out of nowhere during the same time period.
There were a lot of questions like, "Okay, well, are these the same conditions? Is it the conditions that would result in the wildfire, or is it the ignition?"
How do you separate wildfire events? Is one wildfire outline a wildfire event, or if two wildfires with separate outlines happen at the same time, can I combine those into one single event?
If I have a loss in Santa Rosa and a loss in LA, can I combine those into one event? That has a really big impact on how a company may purchase reinsurance to protect their downside.
In 2017, the wildfire loss occurrence definition for wildfires in California and any state for that matter was a 250-mile radius and 10 days—240 hours.
I'm going to show you how big a 250-mile radius is. This is a 250-mile radius.
Look how big that is! So in 2017, if you were an insurance company and let's say you had a wildfire here up in Paradise and a wildfire over here in Oakland and a wildfire down in Santa Barbara, and they all happened at the exact same time, you could combine all of those events in three completely separate different locations into one single loss occurrence.
Think about how crazy that is! Imagine you've got tens of millions, you know, a billion-dollar loss up here and a billion-dollar loss up here and a billion-dollar loss down here.
That has a really big impact on the total size of the event—if it's large or small. Reinsurers quickly realized after the 2017 wildfire season, "Holy moly, this is unsustainable! We can't do this."
What happened after that time period is, or 2017 happened, everybody was like, "Holy moly! We just got hit by a tunnel loss."
Then the Paradise fire happened in 2018.
The Paradise fire—let's look at Paradise.
Okay, Paradise fire—boom!
This area is about an eight-mile radius, so it's a 16-mile diameter, about 200 square miles. There were about 15,000 risks that were in this circle that got destroyed in the Paradise wildfire.
That's like a 90-95% damage ratio in this area. This was a really big miss by a ton of insurance companies.
This area over here in Paradise was ranked by wildfire models as not very risky. What happened was there were a few insurance companies that were just incredibly concentrated in this location in Paradise.
I think what happened was, looking at the extreme profitability that happened over time in the homeowners line in California, insurance companies got greedy.
They found little pockets of business where they could be really profitable, and then they just started writing a bunch of business without thinking about where they could potentially have aggregations of risk that could result in an enormous wildfire loss.
The reason I bring up aggregation is because you remember what we just said about the wildfire loss occurrence definition.
What happened was there was an insurance company that, after the Paradise wildfire, realized that they were insolvent.
What I mean by insolvent is they had more losses than their entire surplus plus the amount of reinsurance that they purchased—aka they weren't going to be able to pay the claims of the policyholders that had losses.
This is a really scary situation. This is totally incredibly scary, right?
Naturally, what they did is tried to bend the rules of the wildfire loss occurrence definition. They said, "Okay, we hear you on your circles," and they took one circle up here in Northern California and chopped the Paradise wildfire in half.
Then they took another circle down over here in Nevada and chopped it in half, and they called these two separate circles—one in Northern California and one over here with a centroid in Nevada—they called these two separate circles two separate events.
What they did is they split the Paradise fire, even though this is clearly one fire, they split the fire in half with two separate circles and they ceded losses to their reinsurance provider twice.
As you can imagine, this totally pissed off all of the reinsurers. It was like a little bit of a loophole in the design of the reinsurance contract.
It wasn't clear on whether or not you could have two circles and split the loss. So, what do you do if you're insolvent? You bend the rules, right? You figure out a way to stay alive.
That equation, I think at the time, was worth the risk of ceding two losses to the reinsurance market and totally tattooing the reinsurance market.
So that really soured a lot of the reinsurance market. I mean, capital began to flee after the 2018 wildfire event.
The cost of reinsurance just rocketed overnight after 2018. I mean, the cost of reinsurance everywhere skyrocketed because of the uncertainty in how to price these wildfires.
There are multiple problems here with wildfires. If you think about it, how do you define it? Who defines it? How do you define it?
Is it wind conditions that cause it, or is it a different cause of loss? Does cause of loss even matter? Is smoke damage included? Where do you draw the line of what can be included and what can't be included?
Then you also have so many other things coming into play, like demand surge, wildfire fighting costs, just all of these different variables.
I'm going to show you a quick video on just why this is so incredibly difficult to manage, and we'll talk through this a little bit more.
This is a video from somebody's house in the Malibu fire, and this is just one of the scariest. I think these people are okay, but Jesus, look at this! You can't run away from that.
Yeah, man, this is super scary.
The reason I show that is because it shows the intensity of some of these wildfire events. The wildfires happen very quickly; they happen very fast.
They can move in incredibly quickly, and you can have no idea that they're coming. It could just be on you, and a wind event can sneak up.
Diablo winds could come out of nowhere, and you know there was a car backfire that caused the fire to start.
You've got 80-100 mile-an-hour winds, and all of a sudden, your backfire's in your backyard, and you can't move. You've got to go.
That's volatility! That's just a super volatile event.
If you think about this in comparison to other catastrophes like hurricanes, with some degree of certainty, you can predict where the thing is going to hit.
With some degree of certainty, you can do this four or five days in advance. As the hurricane continues to move, you can alert people.
You can let people know, "Hey, you need to evacuate. There's a good chance you've got a category five hurricane that's going to hit us. It's going to cause a lot of damage."
With hurricanes, you also have wind fields. So you've got different wind fields. The closest to the eye is a really heavy wind field.
You might have 180 mph winds right next to the eye, but it actually drops off pretty drastically as you get further away from the eyewall.
You can begin to quantify and calculate estimated damage to homes that are going to get hit from hurricanes. You can run simulations on an entire portfolio where you can model a hurricane going over a portfolio 10,000 times and get a probabilistic distribution of what the outcomes might be.
These models have been around for 30 years, and they've gotten very sophisticated over the last 30 years.
There's a lot of science that goes into it. There's a company on the East Coast that literally has jet engines and they blow air at homes to try to knock the homes down to get an understanding of damage ratios on these homes.
Now, fire is just so much different and so much more volatile and so much harder to predict. You have zero degree of certainty on any of this information.
If you think again about hurricanes, where are hurricanes going to have the most damage? It's going to be on the coast.
Now, where is a wildfire going to have the most damage? It could be just completely anywhere, and it can happen very quickly.
It could be wind-driven, which can create its own weather systems.
How wind works, right? If you look at California, the Central Valley is a valley, and you've got the mountains on both sides.
You've got some heat down in the valley and cool air up in the mountains. You've got changing pressure systems that cause wind.
The hot air goes to the cold air, and the cold air goes to the hot air, creating this kind of wind system.
You've got different geographic terrain, different fuel loads, fuel moisture, and fuel types. All of these things can be challenging all at the same time, and it makes it really difficult for a reinsurer to try to grasp on and quantify this.
Like I just said with hurricanes, you can run a stochastic simulation. You can run 10,000 simulations over a portfolio and say, "Okay, I know about what my risk is with some degree of certainty."
Now again, with wildfire, how do you model this event that's happening in LA? How do you model it?
You have no way. You can throw tons of data and science at this, and people are trying to throw tons of data and science at this, but the real difficulty is it's hard to simulate.
It's incredibly hard to simulate and predict with any degree of certainty. You can have wildfires all over the place.
Again, how do you quantify it? If you think about the potential downside scenarios here—knock on wood, worst-case scenario in this potential LA event—I wouldn't wish this on anyone, but the worst-case scenario is you have an earthquake happen at the same time.
This would just completely destroy any modeled scenario that you would ever have.
There are some models out there that think about, "Okay, what's the probability that there's an earthquake that causes fire during a wind scenario?"
That really starts to scare capital. You think about the volatility and what's my return? What's my upside here if this risk is just so volatile?
I think that is a good segue to the next topic, which is getting into market structure.
So, market structure is pretty nuts too. I'm just going to share my screen.
Let's go back to this. You guys don't need to see the whole thing.
Okay, so insurance and reinsurance market.
Market structure: admitted versus non-admitted market and the FAIR Plan.
Let's talk about this for a minute.
Maybe I'll move myself over there.
So the admitted market has to file forms and rates with the state.
If you were looking to write business in California, let's just say Sacramento, and you wanted to charge a certain rate, you have to file your relative rate for that type of risk in that location.
You have to file that with the state, and you have to get it approved. The state has to approve you charging that rate in that location.
That's the admitted marketplace.
The admitted market is kind of like the first line of defense in the insurance market. Most policies in urban areas—like if you live in the city, like in the LA basin or Sacramento or SF—you're probably getting insurance in the admitted market.
This admitted market is to provide some structure and framework to make sure that the insurance citizens aren't getting price gouged.
This is just a general structure in the entire U.S. insurance market.
Then you think about the non-admitted market.
You've got the admitted market, where you have to file rates and forms, and then you've got the non-admitted market.
You could think of this as the wild, wild west.
This is the wild, wild west of insurance rates. You can charge whatever you want; it doesn't have to get approved by the regulator.
In order for a policy to go from the admitted market to the non-admitted market, you have to get declined by two or three admitted carriers in order to transform that risk over into the non-admitted market.
Again, this is to protect consumers.
If you can't get insurance in the admitted market, you have to go to the non-admitted market to get insurance for many of these incredibly risky risks.
If you live in the forest or the woods or even like where this fire is right now, you probably struggled to get any insurance period.
The admitted market just didn't exist. There was no way that the regulator in the region would approve the rates that the insurance companies need to actually get in order to write that business.
So most of the business in these risky areas is non-admitted business.
But if you lived in a really risky location, there's a high likelihood that you couldn't get insurance from either the admitted market or the non-admitted market.
So where do you go? What do you do?
You have to go to the residual market or the insurer of last resort, which is the California FAIR Plan.
The California FAIR Plan is the insurer of last resort. They provide basically a really stripped-down policy.
Their coverage is okay; they offer limits up to $3 million of total insured value for a homeowner and up to $20 million for commercial property.
So if you're a high-value homeowner—like somebody that lives in the impacted location right now, like Pacific Palisades—and you have a $10 million home, you can get a $3 million policy from the FAIR Plan.
Let's just say you couldn't get insurance anywhere else. Then you have to take the remaining exposure net. You've got $7 million of risk that you have to take net.
I'm a bit concerned about that marketplace right now. I think this could be a really sad underinsured loss in LA.
So again, going back to the FAIR Plan, let's think about the FAIR Plan a bit. The dynamics with the FAIR Plan are just insane as well.
God, this whole market's so crazy!
So the California FAIR Plan, the residual market insurer of last resort, is not a government entity. It's kind of like a pseudo-government entity, and it's kind of run by all of the insurance companies in the state.
The FAIR Plan charges way under actuarially sound rates.
The California FAIR Plan charges a policy that's in the woods; they'll charge it like an elevated rate, but it'll be pretty similar to something that's in urban territory.
The FAIR Plan is just totally underpriced. Again, it's meant to be the last resort for anybody that can't get insurance.
What they do on the back end is they take in all this premium and purchase reinsurance.
They try to buy as much reinsurance as they possibly can with the premiums that are coming in the door.
Now, they only buy reinsurance to the one in 40-year return period.
I'm going to say that again; it's probably confusing for some people. They buy reinsurance to the one in 40-year return period.
Most other insurance companies in the entire U.S. market purchase reinsurance up to the one in 30-year return period, depending on your rating, or the one in 250-year return period, depending on your rating.
Again, the reason for insurance companies buying to such high return periods is to protect their balance sheet.
Somebody said here, "FAIR Plan?" Oh yeah, somebody mentioned the FAIR Plan in the chats. Yeah, totally right!
So again, the FAIR Plan buys up to the one in 40-year return period. They are wildly under-reinsured because they can't afford it.
They're not getting actuarially sound rates on the front end, so they buy as much reinsurance as they can, but it doesn't buy that much coverage.
As you can see, issues are starting to brew here. I've been sounding the alarm on this for years, but I've been pushed to the side.
So why is this an issue?
In 2017, the California FAIR Plan had 880,000 risks. Fast forward to 2024, the California FAIR Plan has 400,000 risks.
Think of how crazy that is! Let's just say, on average, the value in California is a million.
What is that? 80 billion?
Got to turn my phone sideways for my calculator. That's 80 billion!
Now that number goes from 80,000 risks to 400,000 risks in like five years.
That 80 billion dollars of exposure goes from 80 billion to 400 billion. That's a lot of exposure in a very short period of time.
It indicates how dislocated the market is and how screwed up the entire California market is.
The amount of exposure that's been funneled into the FAIR Plan is totally crazy.
You think about why did it happen? Why did it explode?
It exploded because in 2018, based on all of the stuff that we've just gone through, the insurance market just totally blew up from the Paradise wildfire.
Reinsurance capital totally evacuated. Loss occurrence definitions changed super rapidly. The regulatory environment got really challenging where the market needed to raise their rates, but they weren't getting the ability to raise their rates.
So you had insurance companies just start non-renewing business and fleeing the state.
All of this was just happening at the same time, and it just got super crazy. All this capital left the market because it just wasn't profitable to do business, and the regulatory environment was just super challenging.
The FAIR Plan has ballooned—totally ballooned.
If you think about the risks that are in there, it's the worst of the worst—the ones that can't get insurance.
So this FAIR Plan is just absolutely ballooned, and they do not have the infrastructure to handle the total ballooning of all of these risks.
This is going to be a big issue. This is going to be a really big issue.
The FAIR Plan purchases as much insurance as they possibly can. I think they buy to the one in 40-year return period.
Anything in excess of the 40-year return period—if there's a loss in excess of the 40-year return period—that loss is assessed on all homeowners insurance riders in the state, admitted homeowners insurance riders in the state.
You can start to imagine how crazy this gets because let's say you have an urban portfolio, and you're a homeowner.
You write homeowners business in the state of California. Let's say your company is like Lemonade, and you write homeowners business in Sacramento only.
Let's just say Sacramento—just keep it simple. You have no wildfire exposure at all, but you just so happen to write 0.1% of the homeowners market in the state of California.
Now you can have an industry event like this that happens to the California FAIR Plan. It blows up the entire FAIR Plan's reinsurance program.
Let's just say, "Boom! Tattooed! Whole reinsurance program gone."
Then let's just say you have a $10 billion loss to the California FAIR Plan. You now have an $8 billion exposure that's going to get assessed on everybody that's writing homeowners business in the state of California.
That's a huge issue! You can not even have any exposure to this loss in California in LA, but you can have this huge assessment on your book just because you wrote homeowners business in the state.
It's insane!
I mean, it's just a huge exposure that I think many insurance companies underestimated and I think still probably continue to underestimate.
Again, let's think about this 40-year return period. Why is the 40-year return period important?
To give you a sense of scale, the reinsurance models that exist for wildfire, again, they're not very good.
They modeled the Paradise wildfire as a one in a hundred-year event. They modeled the Santa Rosa wildfire as like a one in a 60-year event—something like that.
The 2017 and 2018 fires, just to give a sense of scale, were very, very large from a model perspective.
I think this LA fire that's happening right now is probably a modeled one in 200-year event or one in 300-year event.
I think there's a decent likelihood that the California FAIR Plan has a loss well in excess of their reinsurance program, and there's a significant assessment on the insurance companies that write homeowners business in the state of California.
I think this is going to be really sad and incredibly sad.
This is going to totally sting everyone in the entire California marketplace. If you have insurance anywhere in the state of California, you're going to get hit by increased rates or changes in the insurance dynamics in the market.
The FAIR Plan's viability into the future—capital may continue to flee because of the volatility.
The political regime is really challenging to get rate approvals. You can't include reinsurance costs in your upfront rate allocations.
It's just a really challenging market to do business in.
At the same time, it's really challenging to write business in the state, and the reinsurance market has just complete flexibility with rates.
The insurance market moves really slow. The reinsurance market has full flexibility; they can charge and raise rates whenever they want, as quickly as they want.
They could go as high as they wanted, and that market is just a lot more flexible.
The reinsurance market is a lot more flexible with capital than the insurance market.
So yeah, I think this is going to cause a huge rift in the design and structure of the existing insurance and reinsurance market in the state of California.
It's going to be pretty crazy—not in a good way.
I could see some downstream impacts in so many different things.
What makes this fire particularly crazy is, in my opinion, the rebuilding of these homes.
Let's say you've got all of these losses. These are all in high-value areas. Malibu is a high-value area.
Let's just say the average total insured value is $10 million. You've got these high-end homes that have just evaporated.
If you want to rebuild them, they take a very specific skill set to rebuild these homes.
These are like very unique niche homes with fancy architects, high-quality materials, big windows and glass that are just custom.
You probably want to change the living environment, and the downstream impact of the complexity of this loss is just so vast.
It's going to take forever to rebuild this—like five to ten years.
Even then, I don't even know what it looks like. What does it look like five to ten years from now? Do people move? Does the population shift and change?
Does that area rebuild at all? I mean, it's still a lovely place to live in down in California, but I think a lot of people are going to rethink how they live their lives, especially with the downstream impacts just kind of all over the place.
This is really sad. People lose their homes. The real estate market's going to be impacted.
Think about the people selling high-end real estate. Your inventory in that area just evaporated.
Somebody asked a really good question: "Won't this affect home values eventually? As insurance rates skyrocket, then values will need to adjust down to account for increased insurance costs?"
Yeah, I think that is a very likely scenario.
For example, you could look at homes in Florida—very similar situation. You've got an insurance nightmare there in Florida as well, where the cost of insurance is just astronomical.
Yeah, I think that will totally impact house values over in that area.
The dynamics in California are just so challenging because of what is it called? Prop 13?
Oh my God, California is just a nightmare. The whole thing is a nightmare.
So Prop 13 is the property taxes in the state of California.
What this means in California is when you buy property, your property taxes are fixed the year you buy that home, and the property tax value can only increase 2% each year.
So what do we know about CPI and inflation and the money supply? Well, the money supply has increased six and a half percent a year.
That's created this inflated home value in the state of California. All these people bought homes—hard assets in California.
The property tax only went up 2%, but the value of the home is rocketing. It's going up like 10%, 15%, 20%.
That creates a really strange dynamic in the real estate market where you are incentivized to not move, especially if the market's moved on you.
Imagine a scenario where you grew up in San Jose, California. Your family bought a home for $150,000. That home in San Jose is now worth $3 million.
But the job that your family has is still the same. If you were to sell your home for $3 million, great! Good for you; you just made a ton of money.
But if you want to live in another house, you have to buy an equal home. If you did, then your new tax rate is a function of your new home price.
If your income didn't move at the same rate as your property tax rate increases, you're out of luck. You're totally out of luck.
You could see this dynamic everywhere. I encourage anybody, if you haven't been to California, just go around in different neighborhoods and think about it a little bit.
You can literally see it. I encourage anybody to go to Hollywood and walk around the neighborhoods in Hollywood.
You can see these piles of trash—a piece of trash home right next to a $5 million beautiful home.
Then you have a piece of trash home right next to it, and it may be valued at $3 million. It looks like a totally rundown place, and there’s a family living there.
They can't afford to keep it up, and all this stuff. Then you think about it. It makes sense. They bought that home in 1990, and they literally can't afford to move.
So, I mean, this whole situation is just totally screwed. If these people start moving to different locations and they've got these big insurance claims and all this stuff, this whole thing is just totally convoluted and wonky and weird.
I'm going to go back into this insurance marketplace and this one final piece here that makes things even more complicated: the California Wildfire Fund and the utility company involvement.
Okay, this gets crazy.
We're just going to go full solo. Turn my thing off.
So the California Wildfire Fund and the utility company involvement.
The 2017 and 2018 wildfires that happened in the state of California were deemed utility-caused.
That means, you know, PG&E—so you've got three large utility providers in the state of California: PG&E, SoCal Edison, and Sempra, which is down in the San Diego area.
The 2017 and 2018 wildfires were deemed utility-caused, meaning that this utility infrastructure—PG&E has these electricity lines running all over the state.
You had high wind events—80-100 mph winds up in the mountains—and you had this situation called line slap.
You've got these lines that are kind of swinging, and then they slap each other and cause a spark. A spark falls to the ground, starts a fire in the middle of the forest—boom!
Bobs your uncle! 80 mph winds, and the whole place is on fire. You've got a million-acre fire, and it's uncontrollable because it's up in the mountains.
You can't fight it. It's going from crown to crown of these trees, and it's just impossible to stop this stuff.
These fires burn incredibly hot—2,000 degrees. They'll melt steel. They're really, really scary and move really quick.
Given that these wildfires were caused by utility companies, this whole dynamic is so crazy.
Given that these wildfires were caused by utility companies, insurance companies were like, "Oh great! I've got somebody to sue."
So insurance companies have all these losses, right? Like Paradise burns down, and the insurance company goes, "Oh my God! I'm going to go out of business. I need to sue somebody for fault."
Somebody's at fault! "PG&E, you're at fault! You should have had weather stations on this, and you should have prevented this fire from ever happening."
Or maybe your pole fell down, and you should have been maintaining your pole or clearing brush or doing all this stuff.
As you can imagine, this was an absolute disaster for the utility companies in the state of California.
Write this down! You start to understand how convoluted this whole freaking problem is.
You've got utility problems, real estate problems, tax problems, insurance problems—okay, back to the utility companies.
All of a sudden, PG&E is like, "Oh my God! I've got a $15 billion loss in my hands. I literally am insolvent. I can't do this."
PG&E, in a weird scenario, is a publicly traded company, but they provide a service for the people of California.
What's the state of California going to do? Let two-thirds of their state go without power? No!
So where's the money come from? Who has the money? Who's paying this loss to all these insurance companies that are suing the utility company?
PG&E had a huge problem. They were like, "Oh my God! I don't know what to do here."
They had a reinsurance program, they blew through their reinsurance program, and they had losses in excess of their reinsurance program.
At this instance, in 2018, when it was deemed utility-caused, the investment companies or the rating agencies were threatening the state of California and the utility companies that they were going to drop the credit rating on the bonds that they offer the market from investment grade to junk bond status, which is a huge issue.
If you have investment-grade bonds and you're a utility company, that means you can raise capital very cheaply—6-8%.
Let's say now if you're junk bond status and you needed to raise a billion dollars of capital, you might have to pay 15% or 20% interest.
The amount of interest you may have to pay may double or triple.
Why is this a problem? This is a problem because what does the utility company do with increased cost of capital? They pass 100% of that cost onto the consumer.
As you can imagine, the state of California was like, "Oh my God! This is such a huge problem. We can't have that happen. We can't have the utility company go from investment grade down to junk bond status because now the cost of everybody's electricity in Northern California is just going to absolutely skyrocket."
So what do we do? We need a backstop. We need to set something up that protects the utility companies in case this happens just so the rating agencies don't downgrade them to junk bond status.
What they did was set up a $21 billion wildfire fund to protect utility companies from utility-caused wildfires.
Half of that fund—so $21 billion—half of it came from utility companies.
So let's just say $10.5 billion came from utility companies, and $10.5 billion came from consumers.
Basically, everybody in the state paid like a $2.50 tax or fee on their utility bill.
It's for the next 15 years. All of that capital is going to this $21 billion fund.
The other $10 billion is put into the fund by the utility companies.
In order for a utility company to be able to access this fund, they have to take a $1 billion annual aggregate deductible.
So they have to take a billion dollars of loss before they can access the fund.
Additionally, they have to prove that they're meeting safety requirements for managing their exposure.
You've got to put micro-weather stations out everywhere. You've got to improve your lines, clear debris.
There's a huge list of all these things you have to do.
Naturally, the utility companies effectively got bailed out by this backstop, but really the consumers in the state got bailed out.
They got a tax of additional cost that just spread out over time via this utility bill—additional cost—opposed to letting the free market drop the investment quality from investment grade to junk bond status, which would significantly change the cost of electricity in the state.
It's awful out there. It's totally, totally freaking awful out there. Everything's bad. Everything's bad in the California market, particularly surrounding this exposure.
The wildfire exposure impacts so many aspects of just all parts of the economy. It's just a huge problem that exacerbates itself.
The affordability problem is an issue too. Because of the tax situation, it also decreases affordability.
So what do people do when there are fewer affordable homes and shelter? They move to where it's cheaper.
Where has it historically been cheaper? It's in more risky areas, like Paradise Wildfire, or you move further into more exposed locations.
That's just created this bullseye. The bullseye for potential wildfire losses has just increased rapidly because of the entire market dynamics.
I just wanted to get on and explain what's going on in this marketplace because it's so nuts.
It's just totally nuts, and it's so convoluted. All of these pieces are intertwined and connected.
It's political, it's economics, it's reinsurance, it's insurance, it's legal, and you know, rating agencies and tax—all of these different components are all tying into each other, and it's just total chaos.
My thoughts and prayers are out to everybody who's impacted by these wildfires. I mean, it's so incredibly sad.
I couldn't—I can empathize with the situation. I've been following these wildfires and this market for the last 11 or 12 years.
Seeing the stuff on the news or on Twitter just hurts. You can really feel the emotion.
It's a much crappier peril to follow than hurricanes. With hurricanes, some people withstand a hurricane. They'll be out there holding American flags and stuff like this—just totally Florida.
But they chose that; they made that decision. You can make a decision whether or not to leave with a hurricane.
With a wildfire, you can't. I mean, some of my friends are impacted. Anders, I hope you're doing okay, man.
I just couldn't imagine the stress of having to deal with that stuff. I have to deal with the market, which is just stressful enough.
I couldn't imagine actually having to deal with losing a home or having to uproot your entire life and redo everything or lose your retirement or memories—the whole thing.
It's just catastrophic—totally catastrophic.
So yeah, I encourage everybody to be sympathetic. This is just a—these people, while they are wealthy, their lives are forever changed.
They will never forget the stress. You're going to try to—these people are going to try to go to sleep for the next three, four, five, ten years and have dreams about this stuff.
I don't wish that on anybody. That's just horrible.
Anyone who's experienced anything catastrophic or had to deal with anxiety—like that stuff sticks with you. Bad events stick with you, and that's a pretty harrowing event.
So I hope everybody's okay, and I hope you found this informational and useful.
Maybe I'll talk about it more.
Yeah, here we go. Thanks for hanging out! Catch you later.